A Trillion Here, A Trillion There....

"A billion here, a billion there, and pretty soon you're talking real money".
This phrase about government expenditures has become a classic but with great
inflation underway, it needs to be brought up to date.

Everett Dirksen (1896-1969), a Republican senator from Illinois, is often
credited with this saying. Indeed, several people recall that Dirksen said
it on The Tonight Show with Johnny Carson in the 1960s, and that Carson often
used the line in his opening monologues. The Tonight Show television archives
are not easily available, but so many people remember it that the Dirksen
association with the quotation probably was popularized there.

What used to be a billion here, a billion there, is now a trillion. To put
that amount of money in perspective, think of a trillion dollars as a thousand
billion, or a million million. Even in an inflated world where a cup of coffee
has gone from $.25 cents to $2.50, a trillion lucky bucks gets my attention
and respect.

My rule for investing is to never lose sight of the obvious, particularly
when it is so massive that it dwarfs everything else. With our escalating budget
deficits and US Treasury borrowing, this year we'll see a trillion and a half
in new borrowing. And, with hundreds of billions in mortgage losses at Fannie
Mae and Freddie Mac, and massive bank failures costing the FDIC a bundle, we
should expect the same in 2011 and beyond. With the new health care entitlement
reform bill and millions of workers dropping out of the labor force and filing
for early social security, US Treasury borrowing looks certain to remain well
over a trillion dollars a year, at least over my lifetime. There's no question
that a trillion here and a trillion there is real serious money!

You can't help but wonder where the US Treasury gets all of this money. Because
US households save an average of only 3 percent of their income, or about 2
percent of GNP, it certainly won't come from savings. The government needs
to finance deficits equal to 10 percent of GNP, or half of all government spending.
Each month, the Treasury Department has to find cash they can tap into to buy
approximately $120 billion of fresh new debt (about $4 billion a day). So where
exactly is the US Treasury going to find this kind of money?

Up until now, the deficit has gotten financed with some pretty big tricks.
For instance, the Treasury recently got back over $50 billion in TARP money
from the big banks, and the FDIC passed the hat for $50 billion in pre-paying
3 years of FDIC insurance, all quickly invested into Treasuries. Unfortunately,
$50 billion here and $50 billion there won't go very far in a trillion dollar
world.

The really big money for the deficit has come from Quantitative Easing, or "QE",
where the Fed prints fresh money "out of thin air". The Fed has just finished
buying $1.25 trillion in mortgage securities and exploded its balance sheet
from $800 billion, at the beginning of the financial crisis, to over $2.3 trillion
today. That's a hefty $1.5 trillion increase. Foreign central banks have also
been printing money for America's benefit, and they've purchased a whopping
$3 trillion of US Treasuries, including $400 billion of Treasury debt bought
in the last twelve months. (The Federal Reserve and foreign central banks together
have printed up $5.3 trillion). For now, that has taken the pressure off financing
$8.3 trillion of outstanding public market Treasury debt.

As of April Fools' Day, the exact total of US open market debt is a whopping $8,294,870,658,096.94.

QE, and all the Foreign Central Bank and Federal Reserve Bank buying of securities,
have kept ahead of the Treasury deficit. Indeed, QE has left US banks sitting
on $1.1 trillion of free bank reserves they could use to make loans or buy
more securities. Normally, banks don't sit on free reserves for very long and
the Fed has announced they need to think about draining reserves from the banking
system to remove worries that the free reserves might lead to inflation.

Well, you shouldn't worry about the trillion in idle bank reserves as they
won't last long. The US Treasury has printed up a big sign to commemorate
the wisdom of Willie Sutton. When Willie was asked why he robbed banks, he
said 'because that's where they keep the money'! The Treasury has already
cast its longing eyes on the banks' free reserves.

There's no doubt where the Treasury will turn for finance. We are about to
see the greatest stuffing of banks with government securities the world has
ever seen. American banks will be forced to gorge on Treasury securities, and
disgorge bank reserves. Where else can the government get the next trillion
to spend on things like wars, unemployment benefits, and food stamps?

There are a few obvious things to think about here. At the rate of $120 billion
a month, it will only take about nine months to blow through over a trillion
dollars in free bank reserves. Each Treasury auction will find it more difficult
to sell all of the treasury securities, and it will take rising interest rates
to coax out even more reserves from the banks. (When you need to borrow
over $4 billion a day, even a trillion dollars doesn't last long.) By the
end of the year, when the bank reserves are used up buying Treasuries, interest
rates will soar and bond auctions will start to fail. No one will have any
cash left to buy Treasuries unless, of course, central banks crank up the printing
presses again. Look for a QE II, QE III, and QE IV before the dust settles.
Without central banks, there really isn't any source of debt buying large enough
to fund America's deficits.

Looking in the crystal ball that reflects the truth of what our government
is up to, our choices appear to be: i) inflate, or watch interest rates soar;
ii) watch interest rate soar, and inflate; or iii) inflate the money supply
and ultimately drive interest rates relentlessly higher. Either way, interest
rates, particularly longer term, will constantly be pushed up, while future
rounds of money printing will surely promise great inflation in the years to
come. Endless deficits of this magnitude do have serious consequences.

Prior to founding the Specialty Finance Group in 1989,
Mr. Benson acted as a trading desk economist for Chase Manhattan Bank in the
early 1980's and started in the securitization business in 1983 at Bear Stearns,
and helped build the early securitization businesses at Citibank and E.F. Hutton.

Mr. Benson graduated from the University of Wisconsin in
1970 in the Honors Program in Math, and did his doctoral work in Economics
at Harvard University. Mr. Benson is a member of the Harvard Club of New York
and Palm Beach.

The Specialty Finance Group, LLC is a Florida Limited Liability
Company and is registered with the NASD/SIPC as a Broker/Dealer.